Ľubomír Boďa: Risk Management for New Product Development

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• VUB Introduction …

• VUB Introduction
• Risk Management in Development of New Products
• Case Studies

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  • 1. Risk Management for New ProductDevelopmentpresentation for Credit Risk 2013Ľubomír BoďaHead of Asset Quality Management28.2.2013
  • 2. Contents VUB Introduction Risk Management in Development of New Products Case Studies 2
  • 3. TOP 10 banks by total assetsSeptember 2012 Total assets MarketBank Shareholder structure EURO Billions share %Slovenská sporiteľňa 12,0 20.8 Erste Bank 100%VUB 10,9 18.8 Intesa Sanpaolo, 96.76%Tatra Banka 9,1 15.8 Raiffeisenbank 79%ČSOB 5,4 9.4 KBC 100%UniCredit 4,0 6.9 UniCredit Bank 99 %Poštová banka 3,2 5.5 Istrokapital 92.5%PSS 2,2 3.9 Erste Bank 35%, Raiffeisen 32.5%, Bausparkasse Schwäbisch 32.5Prima banka 2,0 3.5 Penta Investments 95%Volksbank 1,7 2.9 Sberbank 99%OTP Bank 1,3 2.3 OTP Bank 97% 3
  • 4. VUB market position is within TOP3 in all key segments 2 Total Assets 18.8% 2 Customer Deposits 18.0% 2 Assets under Management 18.8% 1 Customer Loans (net) 19.0% 2 Loans for house purchases* 25.7% 1 Mortgages 46.8% 2 Branches 20.5% 1 Cards 29.3% 2 ATM 22.9% 3 POS terminals 21.2% as of 30 September 2012, * Building and Intermediate loans not included 4
  • 5. Contents VUB Introduction Risk Management in Development of New Products Case Studies 5
  • 6. Risk Management in Product Set-up Are risk rules just necessary evil than needs to be accepted by business people ? How we are taking risk decisions when defining new product? How precise are standard methodologies when defining completely new products? 6
  • 7. What are typical constrains when developing new product? questions LINKED TO FUTURE OR PRESENT What is expected Hit Ratio (Propensity to Buy)? What is proper Pricing? Do we have appropriate IT solutions and Processes? Do we have employees ready to sell and service the product? What Risk Rules and Constrains should be applied? 7
  • 8. Key pillar of Risk Management during Product DefinitionWhy Credit Risk Management?...and as any cost, it affects profit or even can cause negative profit.Moreover, it is an especially unpleasant type of cost for which you cannot justeasily decide to spend it or not. Amount of cost is affected : 1) Internally by Risk Appetite How is this different or 2) Externally by the Environment special when designing 3) Volume of the Business new product? 8
  • 9. Thin Borderline between Profit and Loss Loss making portfolio Profitable portfolio 9
  • 10. Cost of Risk compared to other Costs... Example of product with rather low risk profile and medium moderate support in marketing campaign. Risk costs on 1 year new bookings vs. 1 year costs for marketing new product.cost of funding risk costs admin costs business margin risk costs marketing costs costs revenues Risk set-up of the Product can be represented by the risk costs (all rules, competencies and processes transformed into 1 margin comparable to the other components of the pricing) Risk set-up is adjustable as long as it is compatible with defined risk appetite and business case is acceptable Open questions usually not addressed properly : Where to book PEREX for risk managers? How to manage fluctuations in cost of funding? How to annualize marketing costs? How to compute cross-sell potential? 10
  • 11. What is the most important in policy set-up for product management? _cumulative_event_ _approval_r _cutoff_sc rate_ ate_ ore_ 0,00% 10,94% A 0,31% 13,21% A 249 0,24% 17,38% A 242 0,18% 22,87% A 235 0,48% 26,05% A 228 0,80% 31,01% B 221 0,69% 42,07% B 214 0,72% 45,66% B 207 0,95% 52,39% B 200 1,22% 64,29% C 193 1,58% 67,84% C 186 1,70% 75,23% C 179 1,89% 80,88% D+ 172 2,20% 84,64% D+ 165 2,68% 89,51% D 158 2,75% 91,58% E+ 151 3,43% 95,09% E+ 144 3,74% 97,07% E 137 4,07% 98,51% E 130 4,13% 99,05% E 123 4,10% 99,63% E 116 4,17% 99,92% E 109 4,21% 99,96% E 102 Cut-Off 4,21% 4,21% 99,96% 100,00% E 95 E 88 11
  • 12. What is the most important in policy set-up for product management? Automatic approval Grey Zone Additional Supervision Automatic Rejection Cut-Off 12
  • 13. What is the most important in policy set-up for product management? +0€ +0€ +1€ +1€ +1€ +1€ +2€ +2€ +2€ +2€ +2€ +3€ +3€ Risk Margins Loan A 4,50%+5€ standard B C 5,00% 7,00% A 1,50% credit line B 3,50% +5€ +5€ C 5,50% 13
  • 14. What is the most important in policy set-up for product management?Pick two features out of three.Example CorporateLending Example Aggressive Slow manual process Consumer Finance involving lawyers and Automated process individual transaction set-up Strong Risk Based Pricing Adjustable pricing according to PICK Possibility to lend transaction conditions customers with various TWO risk profiles for Extended possibility to corresponding margins lend according to transaction set-up Example Pre-Approved Consumer Loans Limited offer only for the best PD customers Favorable pricing due to low risk costs Automated direct mail process 14
  • 15. Extremes in product set-upIs everything adjustable without constrains? Approval Rate approval rate cannot go over 100% regardless of the business plan Pricing Constrains computing proper risk margin is based on assumption of known environment. Set-up of too high risk margin influence the profile PICK of incoming customers and changing the TWO environment on which margin should be applied, which (most probably) leads to underestimation of the computed margin Process Quickness certain steps are mandatory and nine women cant make a baby in one month 15
  • 16. How precise are standard methodologies when defining completely newproducts? PICK TWO 16
  • 17. DiscussionAre we able to hit the estimate for completely new product?Is there something similar we did in thepast?How quickly will be obvious whether theproduct policy is right or wrong? Whatmeasures are quicker than others? 17
  • 18. Summary and Recommendations Establish Risk Cost Measurement with clearly defined Risk Appetite Define product priorities and focus on them (cannot be everything) Find similar attributes in existing products and estimate new product accordingly Start with smaller production Find measures with quicker results Monitor, monitor, monitor,... 18
  • 19. Contents VUB Introduction Risk Management in Development of New Products Case Studies 19
  • 20. Case Study - Expected Risk costs increase for new product XY Expected Inflow of Product XY in YYYY/MM (source: dpt. xxxx): 30 100 000 € Average Probability of Average Loss Given Default 3,42 % Default 55 % Expected Base Risk Costs (Standard branch New Bookings): 566 089 € Walkin clients are significantly more risky than Clients with attributeX are Existing Clients more risky than Others Adjusted Risk Costs based on expected share of Walkin clients and attributeX clients SCENARIO 1 – expected SCENARIO 2 – worst case 50 % Walkin, 50 % with attributeX 80 % Walkin, 70 % with attributeX Adjusted Risk Costs: 729 214 € Adjusted Risk Costs: 900 794 € RISK COSTS INCREASE: 163 125 € RISK COSTS INCREASE: 334 705 € RISK MARGIN INCREASE: 0,53 % RISK MARGIN INCREASE: 1,10 % YEARLY INCREASE: 978 750 € YEARLY INCREASE: 2 008 230 € 20
  • 21. Case Study – check (after 1 year) of the new product with high risk profile XXX (granted from 2011/08) XXX for Young Clients vs. Other XXX 250 7,0% 6,3% XXX for Young 6,0% Quality of XXX for Young clients is significantly lower in presented indicators like Delinquency (DLQ), First Outstanding in Million € 200 DLQ 30-360 5,0% Paymant Default (FPD) and Non Starter Rate (NS) than rest of CL Portfolio 150 4,0% Share of XXX for Young clients on total outstanding without significant changes and with value below 2% in long term 100 Share of XXX for 3,0% Young on Total 2,0% Significantly higher DLQ Rate 30-360 of XXX for Young clients (6,3%) in comparison with DLQ Rate for rest of XXX 1,5% 50 CL Others DLQ 30- (0,6%) granted from 2011/08 1,0% 360 0,6% 0 0,0% New bookings decreased over the month after significant increased in 2012/01. Share of XXX for young on total new 8/11 10/11 CL Outstanding 12/11 2/12 4/12 6/12 CL for Young DLQ 30-360 bookings without significant changes and is fluctuating around 2% CL Others DLQ 30-360 Share of CL for Young on Total Very high level of FPD for young clients with maximum of 11.3% (2012/02) and minimum of 2.6% (2012/04). Significantly higher FPD, NS Rate for young clients in comparison with rest of XXX portfolio XXX New Bookings 35 2,5% XXX for Young Clients 30 Approved AMT in Million € Share of CL for 1,8% 2,0% 25 Young on Total DLQ Rate development of XXX for Young has increasing trend in long term. Significant delinquency increase was 1,5% 20 recorded over the month by 1.4% (+ 26 Accounts) and was driven mainly by following categories : Approved Amount 15 1,0% (2 500 - 3 000€), Contracted Maturity (25-36 months), Regions: Ban. Bystrica, Kosice and Trencin 10 5 0,5% Client Age: Groups 21 y, 22 y represent more then 50% of total portfolio. Clients under 20 years is the most risk part 0 0,0% of portfolio (DLQ Rate significantly above total 6,3%) 8/11 10/11 12/11 2/12 4/12 6/12 CL New Approved AMT Share of CL for Young on Total Approved Amount: Clients usually request the highest allowed loans (category 2 500-3 000€ represents 39% of total CL) and this part reach the highest DLQ Rate of 7.1%NS Rate Contracted Maturity: More then 86% of portfolio outstanding relates to loans with contracted maturity 25-36 months Non Starter Rate 30+; FPD FPD with high DLQ Rate (6.50%)1,50% 12,00% First Payment1,25% 1,2% 10,00% Default CL for Income: Very high DLQ Rate was reported for clients with income 1-350€ ( 8,1%) and 350-600€ (7,1%) young1,00% 8,00% 9,0%0,75% 6,00% Gender: XXX for Young are usually granted to men (72.9% of total outstanding, DLQ Rate 7.1%)0,50% Nonstarter Rate 4,00% Rating: Clients with rating U10-U12 represent 71.17% of total outstanding.0,25% CL for young 2,00% Region: Outstanding is uniformly distributed between all regions. Higher DLQ is recorded in Kosice and Trencin.0,00% 0,00% 8/11 9/11 10/11 11/11 12/11 1/12 2/12 3/12 4/12 5/12 6/12 Nonstarter rate others Nonstarter Rate CL for young 21